The view from the battleground

Major weaknesses in corporate law exposed by the Panama Papers are not news to those who have been trying to regulate corporate behaviour in the country

Panamanian corporate law has traditionally been characterised by what many like to call its ‘flexibility’. I consider this a euphemism.

Panamanian corporate law has always suffered from structural weaknesses, but that weakness has been shrouded by its ‘success’ in the business of selling, as a commodity, the Panamanian corporation, as well as its foundations and trusts.

Panama is the registered domicile for more than half a million Panamanian corporations and foundations – in a country with fewer than four million inhabitants. In short, Panamanian corporations are sold to people from all over the world, who seek to limit their responsibility and to keep their identities secret.

According to the Ministry of Economy of Panama, since 2008 there has been a decrease in the sale of Panamanian corporations. A total of 46,072 Panamanian corporations were registered in 2008, whereas last year 21,156 Panamanian corporations were registered in the year up to October.

Major weaknesses in the Panamanian corporate law system were dramatically exposed by the Panama Papers affair last year, which saw the enormous non-authorised disclosure of data from Panamanian law firm and corporate service provider Mossack Fonseca, with 2.6 terabytes of information leaked.

The scale of the leaks were larger than other notable similar incidents, including WikiLeaks in 2010 (1.7 GB); the Offshore Leaks in 2013 (260 GB); the 2014 Luxembourg Leaks (4 GB); and the Swiss Leaks in 2015 (3.3 GB).

“The Panama Papers affair made it clear that an unsupervised system is unsustainable”

Whatever the revelations exposed by the Panama Papers event, many of the underlying technical issues were not new, at least not to those in Panama who have studied, practised and attempted to regulate corporate behaviour for the past 28 years.

In my opinion, based on my experience as a Panamanian specialist corporate lawyer; a former university professor in the field; a former President of the Ethics Tribunal of the National Bar Association of Panama; a former President of the National Securities Commission of Panama; and founder of the Panamanian Institute of Corporate Governance, the five main weaknesses of the Panamanian corporate system that the Panama Papers leak have exposed to the rest of the world are:

Absence of a specialised regulatory or supervisory body

In Panama there is no one who specifically and exclusively oversees the business of incorporating corporations. There are specialised financial sector regulators for banking, securities and insurance, but, since the establishment of Panamanian corporation law in 1927, incorporation of corporations has always lacked real and effective supervision.

Failure to oversee this has been a major difference to other offshore service centres, where a licence is required and supervisory bodies exist. The Panama Papers affair made it clear that an unsupervised system is unsustainable. Indeed, Panama was warned by international assessments conducted by the International Monetary Fund and the Financial Action Task Force as early as 2000 of this weakness and risk.

In response, certain functions have now been assigned to a new supervisor, the Regulatory Body of Supervision and Regulation of Non-Financial Subjects. This is a first step and its effectiveness will depend on its degree of independence and the resources assigned to it to carry out its technical work. On a positive note, the new body will transition this year from being a dependency of the Ministry of Economy to having a greater degree of autonomy.

Role of lawyers and the registered agent

Every Panamanian corporation must have a registered agent, and Panamanian law reserves this role to Panamanian lawyers or a Panamanian law firm. In addition, the Panamanian constitution reserves the right to practice law in Panama to Panamanians.

So, unlike other jurisdictions, the business of forming corporations and acting as a registered agent is the exclusive preserve of Panamanian lawyers. This has important practical and legal implications. For example, it makes the matter an exclusive topic for Panamanian lawyers, in contrast to other countries where it can be a matter for companies.

Panamanian law firms are also taking advantage of the increased openness of regulation in other jurisdictions to obtain licenses to provide incorporation services for companies from these countries. They successfully compete with other non-lawyer providers and are subject to supervision.

The Panama Papers event has shown that the licensing system is not a panacea, and that there is a problem with the business model itself. However, as an intermediate system, and in the absence of a new model, having a licensing entity and supervising service providers is necessary.

Not having this, as the Panamanian case shows, is a recipe for disaster and dishonesty. Ethics rules applicable to Panamanian lawyers do not specifically address the issue, which is an important weakness.

Another situation that is generated by the exclusivity of the business to lawyers is that it involves the issue of lawyers’ duty of professional confidentiality. This can add difficulties to the issue of cooperation during investigations.

Role of directors and nominee directors

Panamanian corporation law requires a company to have at least three directors, though they are not required to be Panamanian. Until 1997 they had to be individuals, but today a corporation can act as director of another corporation.

Panamanian corporate law does not recognise so-called nominee directors. Nevertheless their use is extensive. There are reported cases in which the same person is a nominee director in more than 11,000 corporations. Another case reports an individual as nominee director of more than 23,000 corporations.

From the point of view of corporate law and logic, this makes no sense and its widespread use leads to irresponsibility in many cases. The problem of Panamanian corporate law, clearly demonstrated by Panamanian jurisprudence, is that the rules on director liability, which exist and do not distinguish between a director and a nominee director, are not effectively and efficiently applied. In short, corporate governance on the issue of director liability does not work properly.

Not piercing the corporate veil

In Panama, the corporation will always be a corporation, regardless of whether it is an instrument constituted exclusively for fraud.

The theory created by Anglo-Saxon jurisprudence of lifting the corporate veil in case of fraud has had very limited application in Panama and in a very particular historical context.

After the US invasion of Panama in 1989 to overthrow dictator Manuel Noriega, the Panamanian state attempted to recover money stolen by the dictatorship by piercing the corporate veil in cases of corporations used as instruments to hide products of corruption and fraud.

“The evolution of the concept of money laundering in Panama has been slow and reactive”

Curiously, it has been determined by Panamanian law that the corporate veil is only unveiled in those cases in which the Panamanian state is the victim and the crime has been committed in Panama. This excludes the bulk of corporations incorporated in Panama to be used offshore, and that may commit fraud outside Panama and against persons who are not the ‘Panamanian state’.

As the Panama Papers controversy clearly demonstrated, a large number, if not all cases of alleged fraud for which Panamanian corporations could be used, were not intended to affect the Panamanian state and were offences committed abroad. With this reality, Panamanian jurisprudence of piercing the corporate veil does not apply.

As I have insisted for the past 22 years (my work ‘Piercing the corporate veil’ was published back in 1995 in the Law Review of the Panamanian Bar Association) the lifting of the corporate veil should apply in any case where a corporation is created solely to commit a fraud.

Limited notion of money laundering

Panama has been reluctant to incorporate tax evasion as a designated offence that constitutes money laundering. This is contrary to the new recommendation of the Financial Action Task Force (FATF), adopted on 15 February 2012.

The evolution of the concept of money laundering in Panama has been slow and reactive. In 1994 it was limited solely to money laundering as a result of drug trafficking, which is only one of the 20 designated categories of offences that constitute money laundering recommended by the FATF.

As a result of several international assessments of Panama by the IMF and the FATF, the basis for including other crimes was expanded in 2003. It now includes the 20 designated categories of offences. However, it does not include tax evasion.

As the Panama Papers affair demonstrates, the discussion of tax evasion as money laundering can no longer be avoided or postponed in Panama.

Time will tell

The Panama Papers affair was for some a case of unacceptable hacking and for others an exemplary journalistic investigation, highlighting and making evident structural weaknesses of Panamanian corporate law.

These weakness had already been detected and warned of many years ago, by Panamanians working quietly and alone in the trenches, in order to have a better and more honest corporate system.

Most of the weaknesses explained have been addressed with the recent enactment of new laws and regulations, which is not only positive, but commands my total support. However, concrete actions, in addition to legal reforms are needed to demonstrate an unequivocal will to act correctly.

Carlos Barsallo is a Board Member of Transparency International, Panama Chapter